As U.S. companies seek to expand internationally with the slowing domestic market, more and more revenues and capital investment originate from overseas operations and with such revenues come operational risks. Starbucks international revenues have jumped to over 30%, with 20% of total company revenues derived overseas, a jump from 9% in 1997. Wal-Mart Stores, Inc. has skewed its investment overseas to over 40% by 2010, up from 30% in 2008. Senior managers should be aware of the risks in such expansions, as they come in unfamiliar forms and restrictions based on the rules and regulations of host countries.
As an example of operational risks, placing in-house consultants in India who remain in the country for over 180 days deems to the host country that the foreign employer is a resident for corporate tax purposes. Various Latin American countries have different corporate entities unfamiliar to U.S. managers, and, depending on the corporate form, the U.S. manager might relinquish management of the foreign entity.
Then there are U.S. rules and regulations that can have an impact on the foreign operation. The most notable one is the Foreign Corrupt Practices Act. Others relate to technologies being exported to certain countries. These international regulations add an additional wrinkle to the corporate development of a company.
What this paper endeavors is to establish the standard flags for corporate managers to review in order to mitigate the international risks for expansions and investment overseas. Each section relates to a decision process or a restriction that controls or restricts its choice for a point of operation. Finally, three helpful appendices, each of which contains a check-off list that can generally be applied by any company, are attached. Each point on each check-off list is particularly relevant to a company interested in forming a foreign operation, factors that help the target country measure the critical issues influencing a U.S. company’s decision making in its international corporate development.
II. MACROECONOMIC CONSIDERATIONS
The first step to identify the needs of a U.S. company overseas comes from macroeconomic trends, strategic needs, and business locations satisfactory to the company’s profile. Location profile refers to attractiveness of the business and living/working environment of the potential location for investment by a company. This important nexus comes from the affinity that a U.S. company has with the foreign market and culture. A U.S. company reviews and studies image, reputation, and overall standard of living conditions in the country where it intends to invest or do business.
Although profitability and returns are the paramount motivating factors for selecting a specific country, long-term investment relationships can be guided by mutually attractive attributes and compatibility that generate further investments and expansion in the same locale. The basic values or sentiments in a foreign destination should be somewhat compatible to a prospective U.S. company. However, these characteristics are difficult to button down, and, many times, are guided by the experience or background of the senior executives of a company. An established, international company such as GE has no problem establishing subsidiaries or investing in other countries, as an example. After measuring the country’s potential payback, GE will diligently study a potential location, review and follow local customs and laws, and hire local talent without needing to delve into long studies about cultural affinity.
Smaller companies might not have such deep, senior management experience and could unreasonably believe that a country will make itself more marketable through changes in its values or traditions. The reality is that immediate accommodation may require extreme realignment of embedded tradition and mores of the foreign destination — a difficult choice indeed for any culture to swallow. And this might not happen, at least in the short run. The bottom line is that smaller companies should evaluate the location profile carefully before making any substantial commitment.
Common sense should prevail to any company expanding internationally: customs, language, and traditions are different from country to country and behooves any company to do its due diligence before establishing long business ties in a foreign venue. Equally important, foreign states should also educate these smaller companies, highlighting the differences and standards that are not obvious and remain important for long-term business relationships. Each party must also make some effort to accommodate their differences to a degree that are acceptable and will not create rancor or discomfort to the other. That being said, the rest of this outline focuses instead on the mechanics that attract U.S. companies. Further discussion on how a country can market its location profile or vice versa should appear in other papers.
The federal and local governments should generally support free enterprise and trade. This is the most attractive business environment. Local and foreign companies should be treated equally by local regulators with a sense of transparency in the way rules and regulations are enforced. A laissez faire approach, that is, little or no bureaucratic interference and deregulation of business, should be the right approach to attract U.S. companies. On the average, as example, nationalization schemes discourage foreign investment whereas privatization policies attract investors. Given the profile of U.S. companies, these policies or lack thereof will determine the initial hurdle by which a U.S. company could even consider the target country.
Then the other macroeconomic element is the national fiscal policy. The central government should control its balance of payments, and, as a trickle down result, target a stable and strong international currency. Other important ingredients include a strong economic policy that to the growth of the Gross Domestic Income per capita. In other words, a foreign government that manages its overall fiscal policy well becomes a leading target for a U.S. company. With such policy, other economic indicators fall straight down: from Balance of Payments through strong currencies. Then any U.S. company can export effectively, either products/services, or can repatriate its earnings.
In the appendices, the check-off lists embrace business planning, part of which invariably comprises of macroeconomic trends – what are the long-term prospects for the target country? Macroeconomic indicators should include, and are not limited to, inflation, currency stability, GDP growth, population, fiscal austerity, and management. These barometers help a company measure the macroeconomic reasons for market entry. Generally, any business or strategic planning must include the basic macroeconomic trends in order to begin the analysis of the merit of any business case. Macroeconomic trends, aims, and policies create the initial groundwork with which a U.S. company begins to test the right target country for possible business development.
Regional/Special/Free Trade Industry Development
Regional/Special/Free Trade zones are a popular means to attract certain company profiles – especially those high tech companies that manufacture and would be involved in regional distribution or exports. These zones might also have tax or duty free incentives tied to them. Generally, the zones are situated away from urban centers, as a means to attract companies and reduce regional unemployment.
Labor force – skilled, literate, reliable, trainable workforce
Companies in the technology sector search regionally for deep and substantially well- educated, skilled workforce. Other important attributes would be their trainability and reliability. The fields that these technology companies seek are technicians, engineers, and managers. Several years ago, as an example, Ireland focused on its local human resources training them for technology. This program, as well as the cost and tax incentives, advanced Ireland as a major technological hub for Western Europe and became for many years a major darling in how a country with limited resources increased its GDP by attracting major multinational companies.
Infrastructure: Communications – reliable, inexpensive broadband wireless, Housing,
The quality of the infrastructure within urban centers can be an important variable to U.S. companies. One Eastern European country, Hungary, in order to attract investments in its high tech sector, has set up nationwide, broadband networks so that not only the company has fast access but also its technical and scientific workforce has access to the same communications technology, which allowed the employees to work from their homes using the same fast access networks as found in their offices. Even the Hungarian standard phone line penetration is fairly deep. These communications features are a determining factor in attracting foreign investment by international companies. Other infrastructure issues include good, affordable housing. Roads also have to be satisfactory. Indeed, various Eastern European countries have extensive studied the profiles of international technology companies and made sure that good infrastructure had been established.
The prospect of a strong, reliable, flexible banking system that allows a new company to register an account locally without considerable regulatory hurdles, and able to transfer funds both domestically and internationally, is an essential element to operate in the country. There are notable accounting firms that, for a small fee, simplify the paperwork, administration and banking, but not all major accounting firms provide such a service or have a presence in every country. In some instances, small companies have to create other offshore operating entities to overcome a hurdle or barrier to financial transactions.
III. REGULATORY AND LEGAL CLIMATE
Each country has countless regulations and its own legal systems. The key determining factor in the evaluation by a company that even considers international market expansion is the transparency of the local regulatory/legal systems: are local regulations and rules obvious or easily obtainable? It is incumbent for a company to implement due diligence, that is, look at the local rules to evaluate the steps to sell a product or service locally. In some countries, as an example, it is illegal to sell telecommunications services unless the provider is the incumbent telecommunications provider. Sanctions for violating such a regulation can be severe and, in some countries, be criminal. Then the local government should anticipate and inform visiting companies on the impact of violations of principal rules and regulations. Again, it behooves a company to study local regulations and not expect that the domestic regulations will carry over internationally.
Judicial systems vary country to country as well. Can the company seek remedy locally? Is the legal system agnostic to foreign owned companies? Is there a registration process needed to even raise a cause of action locally by a foreign company? In some countries, the judicial system treats a foreign owned company, especially when it manages a key service, differently. In Latin America, one European owned water works company faced discrimination by the local judicial system. When history of discrimination becomes well known, other companies would be hesitant to enter the same market.
Standard, non-discriminatory corporate management requirements
For a standard C-type corporate structure (known in Europe as S.A.), some countries require a local national to be on the Board of Directors. In other countries, the senior managers, specifically, the President and Chief Financial Officer, need to be local nationals, with a specific background as well. Indeed, it would not matter if the company has three employees or one thousand, but the senior employees have to be embedded and employed – at whatever cost. Therefore, smaller companies need to conscious of the fact that a foreign national might be part of their management team, whatever the size of the operations. Again, liberal rules and regulations can eliminate these onerous corporate requirements.
International extradition treaties
As part of legal infrastructure, a judgment in a foreign country might not be effective, unless there is an extradition treaty. There are many instances that a company can win a judgment against another company or individual, but the local rules and regulations lack teeth.
International legal comity and recognition
Although international treaties, adopted and ratified by the national government, should guide the judicial branches, local judges, both federal and local, need to follow some sense of comity to have any impact. This policy should include understanding or respecting the other country’s precedents, applying that foreign law, and enforcing them.
IV. REGULATORY LEGISLATION
Labor-management transparent policies
Many countries have promulgated labor management regulations that are substantially different from U.S. labor management policies. Whereas the predominant U.S. companies apply “employee at will”, many countries, including developed countries in Europe, apply lifetime employment contracts to every employee. Other countries require employer sponsored retirement payments way above the average salary as a substitute for lifetime employment agreements. These labor management policy differences should be obvious or easily accessible to a U.S. company considering foreign operations. Many European and Latin American countries apply civil code regulations to labor that leans heavily to employees.
V. EXCHANGE CONTROLS
Exchange controls relate to a company’s ability to transfer its earnings to another
currency, whether it would be its domestic current account or another foreign currency for another subsidiary or operating division. This is clearly an important element to operate internationally for a company’s operational needs are dependent on the flexibility to transfer its earnings. Without such flexibility, the company has no reason to operate in a country that has a conflicting policy.
Some countries require that a foreign company must register its investment in order to restrict the amount to be repatriated. Normally, this registration is processed through a central bank, and represents a curtailment to the repatriation of profits. Whichever way is regarded by the host country, technology companies would regard this as a restriction in doing business.
Registration of foreign capital and technology
Another registration process is consistent documentation of foreign capital infusion. This
registration would allow the host county to control foreign currency loans being received.
Technology transfer agreements might be also be registered as means of documenting that the technology is registered in the host country and the royalties being paid are not a means to obviate repatriation rules.
Some countries disallow the use of foreign currency accounts by foreign investors or local companies.
Repatriation of capital and earnings: liquidity, taxes (treaties), currency restrictions, convertibility, and exchangeability
Governments might tax the repatriation of capital substantially differently from standard local taxing regimes. Other options include limiting the amount to be repatriated limited to the original amount invested by the company.
Guarantees against inconvertibility
Some governments might encourage foreign investments by issuing a guarantee for currency convertibility. In this manner, a foreign company feels assured that its remittances or repatriations would be honored.
VI. OFFSHORE RESTRICTIONS ON FOREIGN INVESTMENT
Restrictions on foreign investment or ownership – telecommunications, insurance companies
Various local industries have reserved investments for the State or for local citizens. In
some countries, exploration or drilling for natural resources such as oil and gas can be restricted. Operating a formerly national service such as telecommunications might still restrict the majority percentage of ownership by a foreign national. The relevant industries would be aviation, naval ports, telecommunications, utilities, and similar strategic businesses of national importance.
Bilateral investment treaties
Bilateral investment agreements exist in different regions throughout the world. In Latin
America, Mercosur, with member countries, Brazil, Argentina, Peru, Chile, Uruguay, and
Bolivia, is an example of a regional bilateral investment treaty that allows the free foreign
exchange market to encourage investments in member countries.
Other types of restrictions
Many nations, both developed and developing, protect their self-interests. One nation defends its borders by not allowing foreigners to own real property at their borders. Others might limit the placement of radio too close to their international borders. So the processes are the same, but the approaches might be different. The basic national assets subject to only local or regulatory control are real property at the international borders, aviation, coastal shipping, international shipping harbors, electronics, financial institutions, or government contracts .
VII. COMPETITION POLICY
This topic elaborates on the various major policies that allow companies to compete in
the markets. For example, if the national policy is currently implementing price controls, this specific policy application discourages competition. Hence, the market is not attractive to the foreign entrant.
Price controls are a national tool to control inflation. Normally imposed by the central government price controls limits the degree to which a company can raise its prices. Since the program is imposed during times of high inflation, companies normally avoid markets until the price controls are lifted.
Fair access is the fair and equitable treatment of any company, regardless of local or foreign ownership. This policy includes access to services, legal systems, contractors and any other third party provisioning in order to compete with the incumbents.
Monopolies and Antitrust
National enforcement of antirust rules encourages the market entry by competitors, including the foreign companies. Anti-competitive behavior creates hurdles for new entrants and smaller companies.
Acquisitions and Mergers
The flexibility to use M&A to expand local operations exhibits another attractive feature for any market entrant. M&A creates liquidity in the marketplace. Any unreasonable restriction to M&A discourages new market entrants.
Trade Barriers – WTO membership
Import restrictions establish another barrier to growth and competition. A WTO membership eliminates this red flag as the WTO establishes a recourse mechanism whenever trade barriers are imposed.
VIII. ENVIRONMENTAL CONTROLS AND POLICY
As the U.S. is not member of the Kyoto Accord, U.S. companies will not be familiar with the issues and mandates of the environmental treaty.
Member of Kyoto Accord
Kyoto Accord impacts principally major utility, energy, oil and gas, and chemical companies. The Accord limits the amount of various emissions by countries and, as a consequence, has an impact on companies directly producing those emissions. The Kyoto Accord does not influence most, if not all, technology companies.
IX. PATENTS, TRADEMARKS AND COPYRIGHTS
Since this White Paper’s targets are technology companies, nothing is more important to these companies as much as IP protection, which is the core ingredient to their operations.
International Treaty signatory – WIPO
The World Intellectual Property Rights Organization (WIPO) is an international
organization dedicated to the facilitation of member protection of the rights to creators and owners of Intellectual Property . Not all nations are members of WIPO; as of 2005, there are 182 signatories to WIPO, and even then, an IP holder still has to be concerned with protecting its IP rights in foreign shores by still abiding to any local rules and regulations that either pre-empt or substantiate its WIPO filings. In 1974, WIPO had become a specialized agency within the United Nations, and as of 1996, WIPO expanded its role through a cooperative agreement with the World Trade Organization.
WIPO is basically an administrative arm handling 23 treaties, broken into three classes:
1. Intellectual Property Treaties, e.g. Paris Convention and Berne Convention
2. Global Protection System Treaties, e.g., PCT and Budapest Treaty
3. Classification Treaties, e.g., International Patent Classification
Adding to this complexity, a company that wishes to extradite a violator to its IP protection must consider extradition treaties as well.
Free Trade Agreements: CAFTA, NAFTA
Free Trade Agreements also play a role for private companies. Currently, CAFTA is under negotiations with regard to IP rights and protections. Although WIPO has a broader reach geographically, each company must review regional FTAs that might be applicable that impact their points of presence. Some might be found for a specific region, such as the Pacific Rim nations. Others are found in the Americas – NAFTA, CAFTA. It pays to look at these FTAs to see what technology markets have been opened up for trade and export.
Protection of the Intellectual Property ( IP) assets
Protection of the IP assets revolves on the ability to seek a remedy upon infringement. In
China, as example, a company must pursue each infringement from province to province.
Therefore, a company must know what local remedy is available for infringement.
Another tool is using extradition treaties, if the infringing company is located in a country with such a treaty; it enables the extradition of the violators to bring them to the injured party’s forum for adjudication.
X. INDUSTRY INVESTMENT POLICY AND INCENTIVES
Fiscal Incentive Investments
Fiscal incentive investments originate from local governments that allow part of a tax bill to be apportioned to governmentally approved projects owned by the corporate taxpayer or a third party. The approved investment projects can be grated total or partial tax exemption. Fiscal incentive investments tend to encourage exports or manufacturing. The Brazilian aircraft manufacturer, Embraer, had such profile.
The actual mechanism is the funneling of investment capital through a government- sponsored funds, which, in turn, can be swapped for shares in the approved investment projects or firms. Negotiability is restricted depending on the project or the firm.
Special-Use Company Incentives
Taiwan uses special use company incentives with Venture Capital companies, by creating various financial incentives: taxable income exclusions, deferred income tax, and 20 percent credit against the value of stocks, for investment in companies that export.
Imports to the trade zone are designated tax and duty-free. Exemption is lost whenever the products/services leave the zone, unless they are incorporated in a manufactured good.
International Finance Center Banking Operations
International finance center banking operations encourage establishment of investment vehicles, holding companies, tax haven activities, and offshore operations in the foreign locale. Such operations provide liquidity of foreign vested capital and serve as potential tax havens for operations.
Countries encourage growth of exports to reduce balance of payments, and create more jobs. The toll used relies on tax exemptions. The basic exemptions include withholding, federal excise, VAT, and service taxes.
Tax and Investment Incentives
Many governments offer tax concessions for technology oriented enterprises, through financing and development funds. Taiwan and China promote such programs.
Various governments offer free local government legal and accounting services. Some German states provide free temporary usage of office until final location is determined, similar to incubation sites.
XI. U.S. RESTRICTIONS TO FOREIGN INVESTMENTS
The following U.S. rules and regulations should have a definite impact to any U.S.
company operating or establishing operations abroad. As an example of the broad reach, the U.S. International Traffic in Arms Regulations specifically address that its rules and regulations pertain to U.S. citizens, companies, or other entities under the control of a U.S. company abroad. Hence the long arm of the following regulations should be relevant in any operation abroad. Further, foreign governments should be aware of these restrictions, as one such example, restrictions against bribery. To encourage these U.S. companies to operate abroad, foreign governments should be aware that any infringement of these laws handcuff any U.S. company operationally even on foreign soil.
US International Traffic in Arms Regulations (ITAR)
International Traffic in Arms Regulations (U.S.C. Title 22, Chapter I, Subchapter M) controls the export/import of defense articles and defense services. In order to export/import, the ITAR require licenses and maintains a munitions list to identify munitions not requiring licenses or segregating those that are restricted. The agency publishes a “No license” list periodically to identify those products that can be exported.
Export Administration Regulations (EAR) and Anti-boycott Rules
The U.S. Department of Commerce, Bureau of Industry and Security, controls exports, re-exports, and activities that threaten national security, foreign policy, and non- proliferation of weapons of mass destruction. The EAR publishes lists of the banned products or services.
U.S. anti-boycott rules, Part 760 of the EAR and Section 999 of the Internal Revenue against targeted foreign terrorists, international narcotics traffickers, and those engaged in activities that proliferate weapons of mass destruction.
Office of Foreign Assets Control (OFAC)
This regulation is administered by the U.S. Department of Treasury, which enforces trade
and economic sanctions based on U.S. foreign policy and international security goals against targeted foreign terrorists, international narcotics traffickers, and those engaged in activities that proliferate weapons of mass destruction. The OFAC maintains lists of banned products as well.
Foreign Corrupt Practices Act (FCPA)
The FCPA, promulgated in 1977, amended in 1988, forbids U.S. citizens or their agents from bribing foreign officials to obtain or retain business, and it demands accurate record keeping and adequate controls fro company transactions. Congress legislated the FCPA to discourage U.S. companies from paying bribes and has rigorously enforced this law. Penalties are severe for violating the FCPA: $2 million against the alleged violating company, $100,000 per each officer or agent, and up to five-year imprisonment. A foreign incorporated subsidiary of a U.S. company may not be subject to the FCPA, but its U.S. parent may be liable if it authorizes, directly or indirectly, or participates in the activity entailing bribery.
Wassenaar Arrangement export controls
As of July 23, 2006, 40 nations participate in the Wassenaar Arrangement. The arrangement has been established in order to contribute to regional and international security and stability, by promoting transparency and greater responsibility in transfers of conventional arms and dual-use goods and technologies. Its purpose prevents, as its sole objective, destabilizations and accumulations of technologies, with
dual purpose – control list of banned technologies that can serve dual purposes in military applications. activities that proliferate weapons of mass destruction.
By carefully reviewing the key concerns of a U.S. company expanding internationally, any country interested in attracted companies can address the right buttons to attract such firms. As an example, by eliminating bribery within its borders, the foreign county can offer an attractive model for doing business in its country. By membership in the WIPO, the country can give assurances that IP will be protected. Most importantly, a U.S. company should feel that its operations in a far- flung land will continue to function smoothly as if it had been in the U.S.
International corporate development is a complex business, for not only a difference in culture is being encountered, but also many types of business practices, barriers, and, at times, customs need to be considered. Underlying themes are profitability and adaptability to seriously attract these companies, and each company and country should realize that this effort of building business enterprises should be collaborative work.